Beginner’s Guide to Rentvesting in Australia
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As house prices rise exponentially, getting on the property ladder is more challenging than ever. This is particularly true of those wishing to live in top-rated cities. Sydney, for example, has seen the average house prices near $1.5 million.
Not many of us have the deposit required to buy a house where we want to live. However, with interest rates at a record low, it’s a very desirable time to purchase property. Rentvesting is becoming increasingly popular.
This article will explore what rentvesting is and whether it suits your financial situation. We’ll cover the pros and cons of rentvesting so that you can make the right decision.
What is Rentvesting?
Rentvesting is an investment strategy where, instead of buying the property they want, rentvestors keep renting in the area they like living in. They then buy an investment property in a more affordable area. The idea is that they can enter the property market sooner without sacrificing their lifestyle by moving to a less desirable location.
Let’s look at an example, say you want to buy a four-bedroom house in Sydney’s inner city. However, as we’ve seen, house prices are too high for you to afford. The rentvesting solution is to rent your dream home in Sydney and buy an investment property in a cheaper suburb.
The rental income from your owned property should help cover your rental payments. In the long term, the rental property investment in the suburb should increase in value. When you sell it for capital gains, you can use that money to purchase a property you want to live in or continue to build your property portfolio.
Rentvesting is also a popular strategy among expats. For example, suppose you want to rent a property abroad without the commitment or cost of purchasing outright. In that case, you could buy an investment property in Australia while renting in your chosen country.
Who is Rentvesting for?
Rentvesting is a viable strategy for many Australians and foreign nationals. Regardless of your income, rentvesting is a sound solution to getting on the property ladder.
Generally speaking, it works best in areas where rental payments vary significantly from mortgage repayments. As negative gearing is a popular strategy in Australia, you will often find locations where rental properties are far lower than the actual property value. It works less effectively in areas where the mortgage repayments are roughly equal to the cost of renting.
Rentvesting is particularly suitable for younger people who cannot afford to get onto the property ladder, in family households where location is crucial, and expats wishing to rent abroad.
Every investor is different. If you’re considering rentvesting, you should seek professional advice about your situation.
Pros of Rentvesting
Rentvesting is a counterintuitive strategy. Rent money is often considered “dead money”. Why would you not live in the property you buy? From maintaining your desired lifestyle to increasing your flexibility, there are many reasons why property investors turn to rentvesting. By looking at the long-term benefits, you can make money without sacrificing the life you want.
Let’s take a look at some of the benefits of rentvesting.
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Wealth building
Rentvesting enables you to start creating your property portfolio. If you buy a property investment in an affordable and non-competitive area, hoping that it will go up in value, you’ll build wealth in the long term.
When you sell, you’ll have enough equity and borrowing power to purchase your own home in the area you wish to live in. In the short term, you will save on higher loan repayments.
In addition, by buying an investment property within your budget, you’re more likely to meet the lending criteria. You will likely get a better interest rate on your home loan and avoid Lender’s Mortgage Insurance.
Lifestyle
Rent where you wish to live. Buy where you can afford it. For many of us, our dream home is unaffordable. Whether we want to live in the inner city or surround ourselves with parks and schools in a family area, it’s usually out of our price range.
Wherever you are in your life, there are many reasons you may want to live in a particular area – local amenities, nearby family, safety and security. Or perhaps, you wish to live abroad while maintaining a property in Australia to supplement your income or to keep your foot in the door.
By rentvesting, you can live where you want to, even if you cannot afford to buy a house there.
Enter the property market
Young Australians are finding it harder and harder to enter the property market. With property prices so high in popular areas, the 20% deposit needed is becoming an unreachable goal for first-time buyers. Therefore, they get saddled with Lender’s Mortgage Insurance and higher home loan interest payments.
Unless first-time buyers accept that they cannot buy the property of their dreams, they won’t get onto the property ladder any time soon. Therefore, turning to rentvesting allows new buyers to begin property investing, accumulate wealth, and live where they want to live. In addition, they’re improving their purchasing power down the line.
Limited responsibility
As a renter, you have limited responsibility. You don’t need to worry about maintenance costs or hire a property manager. Your rental property is the responsibility of the landlord. They will also cover upfront costs, such as stamp duty (costly for foreign nationals).
However, the other side of this is you are responsible for your rental property. Alongside paying your principal and interest repayments for your house, you will also have to pay tax, property managers, and maintenance costs.
The upside is that when you’re buying a property to rent rather than live in, you’re more likely to make sensible decisions. Investment properties come with less emotion; therefore, you’re less likely to make sacrifices in quality. This should mean that upkeep costs and property management fees are lower.
Flexibility
One of the best advantages of rentvesting is that you have the flexibility to live wherever, whatever your personal circumstances. Without the ties of buying a new property each time you want to move house, upgrade or downgrade, it’s far easier to move abroad.
Plus, if your financial circumstances change, for example, you lose your job or get a high paying promotion, you have the freedom to adapt your living situation as needed. With the costs of stamp duty, legal fees, and other buying and selling costs, it’s not always sensible for traditional investors to move around so often.
Tax Benefits
You might be able to claim tax deductions on your investment property. Holding, depreciation, and new fixtures or fitting costs are usually tax-deductible. It’s also possible to make further cost savings as stamp duty, conveyancing, and lending fees might be claimed as a tax deduction.
In addition, if you make a loss on your investment property, you can take advantage of negative gearing. This is when the expenses are more significant than the rental yield. You can leverage these losses to reduce your Australian taxable income. If you’re considering this strategy, it’s wise to seek tax advice about handling these deductions.
Some investors intentionally set up their property investments to make a loss to lower their taxable income. It’s usually done on the presumption that the investor can pay their investment loan monthly fees and that the property values will increase over time.
Choose where to invest
Finally, rentvesting enables property investors to choose where to invest their money. Investors can make objective, sensible decisions about the housing market without the emotional drawback of wondering where to live. Buying an investment property is often easier than choosing where to live.
If you’re considering rentvesting, speak to a mortgage broker for independent advice about which suburbs have strong rental growth to find a suitable property.
Get a free Australian mortgage assessment today.
Cons of Rentvesting
On the other hand, rentvesting isn’t the traditional Australian way to buy a house. Rentvesting isn’t for everyone; some may prefer to buy a property to live in directly or continue renting until they have saved enough to purchase their dream home.
Indeed, there are some disadvantages to rentvesting. For example, you lose out on Capital Gains Tax exemptions. You also risk losing money if your property value doesn’t grow. Consider your personal objectives; is rentvesting right for you?
Loss of full capital gains tax exemptions
Capital Gains Tax (CGT) is charged on rental properties when you sell them for a profit. The amount you pay depends on how long you’ve owned the property, your income tax rate, capital losses, cost of legal fees, estate agent fees, and stamp duty. It can add up to a very costly tax for some investors.
Typically speaking, you will pay tax on the property’s capital growth – the difference between the purchase price and how much you sell it for.
However, if the property is your principal place of residence, you are fully exempt from paying any tax on capital gains. Therefore, by rentvesting, you lose out on this significant cost saving.
There are several other exemptions: your income is lower than the threshold ($18,200), or you make a loss on the property investment.
Less control
While you aren’t responsible for property maintenance, you also lose the freedom to decorate however you like. Whether you wish to add a lick of paint in a different colour or make significant renovations, you have less control over your home.
Some landlords may be more amenable to more minor adjustments, like painting or wallpapering. Yet, you won’t have the flexibility to manage the property as you wish.
Similarly, you have no control over how long you can live there. Ultimately, you do not own the property. The landlord can end your contract whenever they like, and you can do little about it. This lack of security may be a worry for some people.
Peer pressure
Everyone’s own circumstances are different. However, the ‘Great Australian Dream’ is often considered to be buying your own property and enjoying being a homeowner. Rentvesting goes against this idea. This may not bother you if it suits your personal situation.
However, you may experience peer pressure from friends and family who do not understand your nonconformist approach.
Dead money
The common idea is that any money going towards rent is dead; you’re not investing in anything, and you won’t make a profit. Unless you actually buy a property to rent out, you aren’t rentvesting at all. You’re just renting and financially going backwards.
You need to purchase an investment property to improve your financial situation. Even with the rental income to help cover your mortgage repayments, your own rental costs aren’t going towards anything that will help you financially. This may put some people off rentvesting.
The home might not grow in value
Finally, rentvesting comes with the risk that your investment property doesn’t grow in value. There’s no guarantee that your purchase will make a profit, and you might be forced to sell it at a loss in the future.
Plus, you risk losing out on certain first home benefits by using your savings to get an investment loan. When you sell your investment property with the hopes of using any profits (if it’s grown in value) to buy your own home, you won’t have access to the same benefits as other first home buyers.
For example, if you have already bought an investment property, you’ll miss out on the First Home Owner Grants (FHOG) and the First Home Loan Deposit Scheme (FHLDS). If you’ve made a loss on your investment, this might be particularly detrimental to getting new home loans.
Buying a home to live in Vs Rentvesting
Buying your home to live in or rentvesting are both viable investment strategies. Each has their advantages and, crucially, gets you on the property ladder. The main benefit of buying a home to live in is that it’s typically cheaper than rentvesting. Without paying rent, mortgage repayments, and upkeep costs at the same time, it’s less of a financial burden in the short term.
Plus, you can move into your own home straight away rather than continuing to live in someone else’s.
However, the downside is that it can be a lot more expensive to buy a house where you want to live. Rentvesting allows you to pay more affordable rent and continue to live in desirable areas. At the same time, you buy a home in a less popular suburb and build rental income and capital growth.
The long term goal is to sell the investment property to buy a home in a better location or move there when you’re ready. Both investment strategies have their upsides and disadvantages. It’s essential to consider both and seek advice if you’re conflicted.
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Steps to becoming a rentvestor
Before becoming a rentvestor, there are a few considerations to think about. Buying more affordable investment property still has the high costs and stress of purchasing any house. Looking for the right home loan with a relevant credit provider is a significant decision.
It’s worth seeking the help of a mortgage broker with an Australian Credit Licence to help secure the right home loan for you.
Deposit
You must save as large a deposit as you can. The more, the better. You’ll need to borrow less from the credit provider with greater purchasing power. Therefore, you’ll pay less interest on the loan amount, avoid paying Lenders Mortgage Insurance and improve your chances of loan approval from lenders.
The general rule is that buyers should save at least 20% of the property value as a deposit. To buy a property worth $1,000,000, buyers need a $200,000 down payment. This is quite a hefty amount to save and would require serious belt-tightening. Whereas, if rentvestors look to buy property in a cheaper area – say, with a mean property price of $500,000 – they only need to save $100,000.
It’s best to aim for a property that is undervalued in an area that is undervalued. Hopefully, over time, the property will rise in value.
Market research
Researching the local property market to find a cheap suburb with vast growth potential is crucial. The most considerable risk with rentvesting is that you make a loss on your investment. Therefore, it’s essential that you thoroughly look into the best places to purchase your property.
Your strategy should consist of working out your criteria, researching the key suburbs, shortlisting potential properties, valuing your desired property, and negotiating with the vendor. It’s somewhat easier to find investment properties than homes to live in as less emotion and personal objectives are involved. A buyer’s agent can help you through the process.
In addition, you’ll also need to look at home loans. Don’t just check out the interest rate, but also look at the comparison rate and additional features, such as an offset account. If you’re unsure where to begin, seek personal advice from a mortgage broker with an Australian Credit Licence.
Long-term planning
Remember to think long term. Rentvesting works best when the property investment location has a strong potential for long term growth. Or, you might consider living there yourself one day. It’s important to remember that while rentvesting can be costly in the short term, it’s the long-term benefits you’re interested in.
Extra costs
It’s essential to take into account the extra costs of rentvesting. Buying any property is expensive, and you’re often faced with many hidden fees.
During the initial purchase, you’ll have to save a significant deposit. It’s generally sensible to factor another 10% of the property’s value into additional expenses. If you choose to use the help of a buyer’s agent (which could be handy if you’re living abroad), you will need to pay for their services.
You probably won’t need to pay your mortgage broker as they typically receive a commission from the lenders. However, there will likely be many costs that come with your home loan. These costs are likely to add up, from loan application fees to Lenders Mortgage Insurance and the credit provider property valuation.
You’ll also have to pay legal fees to your solicitor to draw up a contract of sale and organise the exchange. Beyond the mortgage, there are stamp duty, property transfer, and mortgage registration fees to pay to the government. Then, you’ll have to pay for pest and building inspections.
Once you own the property and the transaction is completed, the costs don’t stop. You’ll likely face ongoing fees and property maintenance costs, as we mentioned earlier. Plus, you should budget for emergencies. You will also have to pay for advertising to attract tenants and consider how you will cover yourself should the property remain vacant for any period.
While these costs come with any property, whether you’re rentvesting, traditionally investing, or living in your house, it’s important to remember that rentvestors have to pay additional rent on top. It can be pretty expensive in the short term.
Should I consider Rentvesting?
There is no right or wrong answer as to whether you should rentvest or not. There are certain tax benefits and advantages of improving your borrowing power. However, it comes with the risk that you make a loss on the property in the long term.
However, the general nature of any investment is risky. And, if you’re living abroad, rentvesting is a viable strategy to stay on the property ladder in Australia while you’re living elsewhere. Rather than buying a property abroad (which might put down roots where you don’t want to or be too expensive), buy a property in Australia and use its rental yield to afford life as an expat.
It helps to speak with an expert who can advise you on what you need to do. Feel free to ask one of our specialist expat mortgage brokers to find out if rentvesting is the right strategy for you.
Get a free Australian mortgage assessment today.
Frequently asked questions
Rentvesting is a strategy for buying an investment property in an affordable area while renting in a more desirable, expensive location. It’s a good strategy for first-time buyers or expats to get on the property ladder without committing to living in an area they don’t want to. The long term aim is that the property should rise in value, and you use the profit to buy a home you want.
Rentvesting comes with the added risk that your property won’t go up in value, and you make a loss when selling. Plus, while you have the freedom to move around, you don’t have any control over the property you live in. Landlords can end your tenancy whenever they wish, and you cannot make any significant renovations to the house.
With the advantages of negative gearing, it’s often cheaper to rent than buy in Australia. Therefore, many young Aussies take to rentvesting, purchasing an investment property in an affordable area while renting elsewhere. It’s often a quicker and easier way to get into the property market with long term benefits.
Rentvestors make money from their rental income. They use this to pay for their mortgage and own rental payments. In the long term, they hope their property goes up in value to sell it for profit and buy a house they want to live in. Rentvestors are often financially better off than traditional buyers in the future.
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